AMD Could Return To Profitability In Q3: New Products & Alternate Growth Markets In Focus

Declining PC shipments combined with internal factors such as the change in leadership, a temporary manufacturing glitch and a slow response to rapidly changing consumer needs negatively impacted AMD’s (NASDAQ:AMD) growth in 2012. The company announced a three part restructuring plan in Q3 2012 in an effort to strengthen its competitiveness in the market and better manage its expenses and cash. With better operational efficiency, AMD managed to lower its operating net loss from $473 million and $146 million in Q4 2012 and Q1 2013, respectively, to $74 million in Q2 2013.

AMD will declare its Q3 2013 earnings on October 17. It estimates revenues to increase in excess of 20% sequentially and hopes to return to profitability in the quarter. With renewed demand in its traditional PC segment and growth opportunities in new markets, the company focuses on improving its financial and operational results in the future. It claims to be on track to reach its operating expense target of approximately $450 million per quarter this year.

PC Shipments To Decline For The Second Consecutive Year In 2013; New Products & Markets To Help Spur Demand For AMD

The cannibalization by tablets and smartphones combined with weak reception for Windows 8 OS, the slowing enterprise market, consumer softness in mature markets (the U.S. and Western Europe) and slowing demand from emerging markets are the main factors leading to the slump in the PC market. PC sales declined marginally in 2012, and research firm IDC estimates shipments to decline by 9.7% in 2013.

IDC expects the negative trend to persist next year as well and predicts modest growth 2015 onward. [1] However, while overall PC shipments are forecast to decline for the next few years, IDC estimates the portable PC segment to grow at 8.7% between 2013 – 2017.

AMD believes that its updated product portfolio better positions it to gain share in the traditional PC market as well as generate higher revenues from new growth markets. Aiming to lower its dependence on the traditional PC market, AMD intends to derive 40%-50% of its revenue from high growth business, including semi-custom, ultra-low power client, professional graphics, dense server and embedded solutions, in the next two to three years. It has a robust pipeline of upcoming products and platforms which we believe could fuel demand for its products in 2013 and beyond.

Increasing Presence In Game Consoles To Diversify Revenue Base

AMD devised a unified gaming strategy in March this year that addresses its plan to drive the gaming market across consoles, cloud platforms, tablets and PCs. It believes that it is effectively positioned to drive the next revolution in gaming and now powers all major next generation consoles including Sony’s PlayStation 4, Nintendo’s Wii U and Microsoft’s (NASDAQ:MSFT) Xbox One. AMD believes that gaming is one of the key pillars of its embedded custom chip business. Despite stiff competition from other forms of gaming, game consoles account for 42% of the $65 billion global video game market. [2]

Previously AMD’s graphic technologies were integrated into Microsoft Xbox 360, Nintendo Wii and Nintendo Wii U. AMD has never sold GPUs for game consoles, but received royalties for each console that utilized its graphics technology. However, the next generation Microsoft and Sony game consoles will utilize AMD’s system-on-chip Jaguar core and Radeon HD graphics chips. In short, AMD will now sell chips to these players instead of licenses.

Though the gaming business offers lower gross margins compared to the corporate average, AMD claims that the same has comparatively lower operating expenses, and consequently high operating margins, as its customers fund a large portion of the engineering expense. For the next few quarters, AMD expects low double-digit operating margin for this business which it believes will more than offset the impact of lower gross margin.

AMD expects the upcoming semi-custom SoC products for Sony and Microsoft to be the primary revenue drivers this quarter and beyond.

Temash To Help Leverage Growth In Alternate Markets

In addition to the small form-factor notebook, AMD’s recently introduced Temash platform targets the fast growing tablet and hybrid market segments. Temash is the industry’s first quad-core x86 SoC and promises significant performance and power improvement over its predecessor. It offers a longer battery life and is specifically targeted at high performance tablets that can run full HD games and productivity applications.

Temash targets notebooks in the $350–$550 range, which has been AMD’s strong point historically. It has a number of upcoming touch-enabled Windows 8 notebooks at the $399 price point and intends to target the fast growing 7 inch form factor tablet market.

Though AMD launched its Temash platform a few months ahead of Intel’s Bay Trail, it faces stiff competition from Intel as the company intends to extend its product line across screen sizes and price points in both tablets and PCs. In its recent earnings call, Intel announced that tablets powered by its processors could be available for as low as $199 and below in the future.

While we believe that AMD’s growing focus on the tablet market is a good long-term strategy, we do not think it has a significant impact on its stock price. The company still has no plans to manufacture smartphone chips in the near future. We think AMD has a long way to go before it can effectively compete with Intel and established ARM players in the mobile computing market.

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